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Risk Premia and Knightian Uncertainty in an Experimental Market Featuring a Long-Lived Asset

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  • John Griffin

    (U.S. Department of Defense)

Abstract

Objectives: I examine risk premia and the influence of Knightian uncertainty in a laboratory market featuring a long-lived asset. Methods: I employ an experimental asset market, utilizing features which are designed to forestall bubbles and crashes. I alter the riskiness of the asset from market to market along two dimensions— expected variance and upside/downside potential. Furthermore, I include a treatment which introduces uncertainty with respect to the expected value of the asset. Results: Bubbles and crashes are absent. Positive, statistically significant risk premia emerge. The risk premia are not sensitive to expected variance, but do vary positively with the magnitude of potential loss. The introduction of Knightian uncertainty does not appear to influence market prices, however it does increase trading volume. Conclusions: When speculative activity is tempered, risk aversion is manifest in market prices. Subjects appear to view risk in the context of potential loss rather than volatility. Return premia for uncertainty are absent, suggesting a lack of uncertainty aversion. Increased trading activity in the presence of uncertainty may be due to differing opinions with regards to the value of the asset or to divergent levels of uncertainty aversion.

Suggested Citation

  • John Griffin, 2015. "Risk Premia and Knightian Uncertainty in an Experimental Market Featuring a Long-Lived Asset," Fordham Economics Discussion Paper Series dp2015-01er:dp2015-01, Fordham University, Department of Economics.
  • Handle: RePEc:frd:wpaper:dp2015-01er:dp2015-01
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    More about this item

    Keywords

    Risk Premia; Risk Aversion; Loss Aversion; Ambiguity; Uncertainty;

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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